8/9/17: Euro complicates ECB's decision space

My pre-Council meeting analysis of the ECB monetary policy space was published in Sunday Business Post yesterday: https://www.businesspost.ie/opinion/currency-moves-complicate-ecbs-decision-396981.  It turned out to be pretty much on the money, focusing on euro FX rates constraints and QE normalisation path...

7/9/17: Deutsche Mark Euro?.. ECB, Taylor rule and monetary policy

In our Economics course @MIIS, we are covering the technological innovation contribution to the break down in the wage inflation, unemployment, and general inflation (Lecture 2). Here is fresh from the press data showing the divergence between actual monetary policy and the Taylor rule in Germany:

22/6/17: Unwinding Monetary Excesses: FocusEconomics

Focus Economics are running my comment (amongst other analysts') on the Fed and ECB paths for unwinding QE: http://www.focus-economics.com/blog/how-will-fed-reduce-balance-sheet-how-will-ecb-end-qe.

14/6/17: Unwinding the Mess: Fed's Road Map to QunE

As promised in the previous post, a quick update on Fed’s latest guidance regarding its plans to unwind the $4.5 trillion sized balance sheet, to the Quantitative un-Easing...

First, the size and the composition of the problem:

So, as noted in the post here: http://trueeconomics.blogspot.com/2017/06/13617-unwinding-mess-ecb-vs-fed.html, the Fed is aiming to gradually unwind the size of its assets exposures on both, the U.S. Treasuries and MBS (mortgage-backed securities). This is a tricky task, because simply dumping both asset classes into the markets (aka, selling them to investors) risks pushing yields on Government debt up and value of Government bonds down, as well as the value of MBS assets down. The problem with this is that all of these assets are systemically important to… err… systemically important financial institutions (banks, pension funds, investment funds and insurance companies).

Should yields on Government debt explode due to the Fed selling, the U.S. Government will simultaneously: 1) pay more on its debt; and 2) get less of rebates from the Fed (the returned payments on debt held by the Fed). This would be ugly. Uglier yet, the value of these bonds will fall, creating pressure on the assets valuations for assets held by banks, investment funds, insurance companies and pensions funds. In other words, these institutions will have to accumulate more assets to cover their capital cushions and/or sustain their funds valuations. Or they will have to reduce lending and provision of payouts.

Should MBS assets decline in value, there will be an assets write down for private sector financial institutions holding them. The result will be the same as above: less lending, more expensive credit and lower profit margins.

With this in mind, today’s Fed announcement is an interesting one. The FOMC “currently expects to begin implementing a balance sheet normalization program this year, provided that the economy evolves broadly as anticipated,” according to today’s statement. And the FOMC provides some guidance to this normalization program:

Instead of dumping assets into the market, the Fed will try to gradually shrink the balance sheet by ‘rolling off’ a fixed amount of assets every month. At the start, the Fed will ‘roll off’ $10 billion a month, split between $6 billion from Treasuries and $4 billion from MBS. Three months later, the numbers will rise to $20 billion per month: $12 billion for Treasuries and $8 billion for MBS. Subsequently, ‘roll-offs’ will rise $10 billion per month ever three months ($6 billion for Treasuries and $4 billion for MBS). The ‘roll-off’ will be capped once it reaches $30 billion for Treasuries and $20 billion for MBS.

This modestly-paced plan suggests that the ‘roll off’ will concentrate on non-replacement of maturing instruments, rather than on direct sales of existent instruments.

What we do not know: 1) when the ‘roll off’ process will begin, and 2) when will it stop (in other words, what is the target level of both assets on Fed’s balance sheet in the long run. But the rest is pretty much consistent with my view presented here: http://trueeconomics.blogspot.com/2017/06/13617-unwinding-mess-ecb-vs-fed.html.




PS: A neat summary of Fed decisions and votes here: http://fingfx.thomsonreuters.com/gfx/rngs/USA-FED/010030ZL253/

14/6/17: The Fed: Bravely Going Somewhere Amidst Rising Uncertainty

Predictably (in line with the median investors’ outlook) the Fed raised its base rate and provided more guidance on their plans to deleverage the Fed’s balance sheet (more on the latter in a subsequent post). The moves came against a revision of short term forecast for inflation (inflationary expectations moved down) and medium turn sustainable (or neutral) rate of unemployment (unemployment target moved down); both targets suggesting the Fed could have paused rate increase.

Rate hike was modest: the Federal Open Market Committee (FOMC) increased its benchmark target by a quarter point, so the new rate range will be 1 percent to 1.25 percent, against the previous 0.91 percent. This marks the third rate hike in 6 months and the Fed signalled that it is on track to hike rates again before the end of the year (with likely date for the next hike in September). The forecast for 2018 is for another 75 basis points rise in rates, unchanged on March forecast.

Interestingly, the Fed statement highlights that inflation (short term expectations) remains subdued. “Inflation on a 12-month basis is expected to remain somewhat below 2 percent in the near term but to stabilize around the committee’s 2 percent objective over the medium term,” the FOMC statement said. This changes the tack on previous months’ statements when the Fed described inflationary outlook as “broadly close” to target. Data released earlier today showed core consumer price inflation (ex-food and energy) slowed in May for the fourth straight month to 1.7 percent y-o-y. This is below the Fed target rate of 2 percent and suggests that monetary policy is currently running countercyclical to inflation. On expectations side, FOMC lowered its median forecast for inflation to 1.6 percent in 2017, from 1.9 percent forecast published in March. The FOMC left its forecasts for 2018 and 2019 unchanged at 2 percent.

The Fed, therefore, sees inflation slump to be temporary, which prompted U.S. 2 year yields to move sharply up:

Source: @Schuldensuehner

Which means that today’s hike was not about inflationary pressures, but rather unemployment, which dropped to a 16-year low at 4.3 percent in May.

As labour markets continue to overheat (we are now at 4.2 percent forecast 2017 unemployment and with over 1 million vacancies postings in excess of jobs seekers, suggesting a substantial and rising gap between the low quality of remaining skills on offer and the demand for higher skills), the Fed dropped its estimate of the neutral rate of unemployment (or, in common terms, the estimated minimum level of unemployment that can be sustained without a major uptick in wages inflation), from 4.7 percent in march to 4.6 percent today. At which point, it is worth noting the surreality of this number: the estimate has nothing to do with realistic balancing out of skills supply and demand, and is mechanically adjusted to match evolving balance between actual unemployment trends and inflation trends. In other words, the neutral rate of unemployment is Fed’s voodoo metric for justifying anything. How do I know this? Ok, consider the following forecasts & outlook figures from FOMC:

• 2017 GDP growth at 2.2% compared to 2.1%, unemployment rate at 4.2% compared to 4.5% prior, and core inflation at 2.0%, same as prior. So growth outlook is, basically, stable, but unemployment is dropping and inflation not budging. 
• 2018 GDP growth unchanged at 2.1%, inflation unchanged at 2.0%, and unemployment 4.2% vs 4.5% prior. So unemployment drops significantly, but GDP drops too and inflation stays put.
• 2019 GDP 1.9% vs 1.9% prior, unemployment 4.2% vs 4.5% prior and inflation 2.0% vs 2.0% prior. Same story as in 2018. 

In other words, it no longer matters what the Fed forecasts for growth and unemployment, inflation stays put; and it doesn’t matter what it forecast for growth and inflation, unemployment drops, and you can stop worrying about joint forecast for inflation and unemployment, growth remains remarkably stable. It’s the New Normal of Alan Greenspan Redux.


The FOMC next meets in six weeks, on July 25-26. Here is the dots chart of Fed’s expectations on benchmark rate compared to previous:

Source: https://www.bloomberg.com/graphics/fomc-dot-plot/

The key takeaway from all of this is that the Fed is currently at a crossroads: the uncertainty about key economic indicators remains elevated, as the Fed is compressing 2017-2018 guidance on rates. In other words, more certainty signalled by the Fed runs against more uncertainty signalled by the economy. Go figure…

13/6/17: Unwinding the Mess: ECB vs Fed

My guest post on the potential paths to unwinding monetary policies excesses by the Fed and ECB is available on FocusEconomics : http://www.focus-economics.com/blog/the-fed-ecb-at-a-crossroads-unwinding-qe.

10/6/2017: And the Ship [of Monetary Excesses] Sails On...

The happiness and the unbearable sunshine of Spring is basking the monetary dreamland of the advanced economies... Based on the latest data, world's 'leading' Central Banks continue to prime the pump, flooding the carburetor of the global markets engine with more and more fuel.

According to data collated by Yardeni Research, total asset holdings of the major Central Banks (the Fed, the ECB, the BOJ, and PBOC) have grown in April (and, judging by the preliminary data, expanded further in May):

May and April dynamics have been driven by continued aggressive build up in asset purchases by the ECB, which now surpassed both the Fed and BOJ in size of its balancesheet. In the euro area case, current 'miracle growth' cycle requires over 50% more in monetary steroids to sustain than the previous gargantuan effort to correct for the eruption of the Global Financial Crisis.

Meanwhile, the Fed has been holding the junkies on a steady supply of cash, having ramped its monetary easing earlier than the ECB and more aggressively. Still, despite the economy running on overheating (judging by official stats) jobs markets, the pride first of the Obama Administration and now of his successor, the Fed is yet to find its breath to tilt down:

Which is clearly unlike the case of their Chinese counterparts who are deploying creative monetarism to paint numbers-by-abstraction picture of its balancesheet.

To sustain the dip in its assets held line, PBOC has cut rates and dramatically reduced reserve ratio for banks.

And PBOC simultaneously expanded own lending programmes:

All in, PBOC certainly pushed some pain into the markets in recent months, but that pain is far less than the assets account dynamics suggest.

Unlike PBOC, BOJ can't figure out whether to shock the worlds Numero Uno monetary opioid addict (Japan's economy) or to appease. Tokyo re-primed its monetary pump in April and took a little of a knock down in May. Still, the most indebted economy in the advanced world still needs its Central Bank to afford its own borrowing. Which is to say, it still needs to drain future generations' resources to pay for today's retirees.

So here is the final snapshot of the 'dreamland' of global recovery:

As the chart above shows, dealing with the Global Financial Crisis (2008-2010) was cheaper, when it comes to monetary policy exertions, than dealing with the Global Recovery (2011-2013). But the Great 'Austerity' from 2014-on really made the Central Bankers' day: as Government debt across advanced economies rose, the financial markets gobbled up the surplus liquidity supplied by the Central Banks. And for all the money pumped into the bond and stock markets, for all the cash dumped into real estate and alternatives, for all the record-breaking art sales and wine auctions that this Recovery required, there is still no pulling the plug out of the monetary excesses bath.

10/6/17: Cart & Rails of the U.S. Monetary Policy

So, folks, what’s wrong with this picture, eh?

Let’s start thinking. The U.S. Treasury yields are underlying the global measure of inflation since the onset of the global ‘fake recovery’. Both have been and are still trending to the downside. Sounds plausible for a ‘hedge’ asset against global economic stagnation. And the U.S. Treasuries can be thought of as such, given the U.S. economy’s lead-timing for the global economy. Except for a couple of things:

1. U.S. Treasury is literally running out of money (by August, it will need to issue new paper to cover arising obligations and there is a pesky problem of debt ceiling looming again);
2. U.S. Fed is signalling two (or possibly three) hikes over the next 6 months and (even more importantly) no willingness to restart buying Treasuries again;
3. U.S. political risks are rising, not abating, and (equally important) these risks are now evolving faster than global geopolitical risks (the hedge’ is becoming less ‘safe’ than the risks it is supposed to hedge);
4. U.S. Fed is staring at the prospect of potential increase in decisions uncertainty as it is about to start welcoming new members ho will be replacing the tried-and-trusted QE-philes;
5. Meanwhile, the gap between the Fed policy’s long term objectives and the reality on the ground is growing: private debt is rising, financial assets valuations are spinning out of control and 

So as the U.S. 10-year paper is nearing yields of 2%, and as the premium on Treasuries relative to global inflation is widening once again, the U.S. Fed is facing a growing problem: tightening rates is necessary to restore U.S. dollar (and U.S. Treasuries) credibility as a global risk hedge (the key reason anyone wants to hold these assets), but raising rates is likely to take the wind out of the sails of the financial markets and the real economy. Absent that wind, the entire scheme of debt-fuelled growth and recovery is likely to collapse. 

Cart is flying one way. Rails are pointing the other. And no one is calling it a crash… yet…

16/5/17: Navigating the Bubbling Up Investment Seas

Here are the slides from my presentation at the IPU Conference 2017 two weeks ago:

15/4/17: Unconventional monetary policies: a warning

Just as the Fed (and now with some grumbling on the horizon, possibly soon, ECB) tightens the rates, the legacy of the monetary adventurism that swept across both advanced and developing economies since 2007-2008 remains a towering rock, hard to climb, impossible to shift.

Back in July last year, Claudio Borio, of the BIS, with a co-author Anna Zabai authored a paper titled “Unconventional monetary policies: a re-appraisal” that attempts to gauge at least one slope of the monetarist mountain.

In it, the authors “explore the effectiveness and balance of benefits and costs of so-called “unconventional” monetary policy measures extensively implemented in the wake of the financial crisis: balance sheet policies (commonly termed “quantitative easing”), forward guidance and negative policy rates”.

The authors reach three main conclusions:

1. “there is ample evidence that, to varying degrees, these measures have succeeded in influencing financial conditions even though their ultimate impact on output and inflation is harder to pin down”. Which is sort of like telling a patient that instead of a cataract surgery he got a lobotomy, but now that he is awake and out of the coma, everything is fine. Why? Because the monetary policy was not supposed to trigger financial conditions improvements. It was supposed to deploy such improvements in order to secure real economic gains.
2. “the balance of the benefits and costs is likely to deteriorate over time”. Which means that the full cost of the monetary adventurism will be greater that the currently visible distortions suggest. And it will be long run.
3. “the measures are generally best regarded as exceptional, for use in very specific circumstances. Whether this will turn out to be the case, however, is doubtful at best and depends on more fundamental features of monetary policy frameworks”. Wait, what? Ah, here it is explained somewhat better: “They were supposed to be exceptional and temporary – hence the term “unconventional”. They risk becoming standard and permanent, as the boundaries of the unconventional are stretched day after day.”

You can see the permanence emerging in the trends (either continuously expanding or flat) when it comes to simply looking at the Central Banks’ balance sheets:

And the trend in terms of instrumentation:

The above two charts and the rest of Borio-Zabai analysis simply paints a picture of a sugar addicted kid who locked himself in a candy store. Good luck depriving him of that ‘just the last one, honest, ma!’ candy…

12/4/17: Incoming Inflation Uptick: Gear Up

My contribution for Manning Financial on the topic of gearing investment portfolios against incoming uptick in inflation is now available here: https://issuu.com/publicationire/docs/mf__spring_2017?e=16572344/47063502.

12/1/17: NIRP: Central Banks Monetary Easing Fireworks

Major central banks of the advanced economies have ended 2016 on another bang of fireworks of NIRP (Negative Interest Rates Policies).

Across the six major advanced economies (G6), namely the U.S., the UK, Euro area, Japan, Canada and Australia, average policy rates ended 2016 at 0.46 percent, just 0.04 percentage points up on November 2016 and 0.13 basis points down on December 2015. For G3 economies (U.S., Euro area and Japan, December 2016 average policy rate was at 0.18 percent, identical to 0.18 percent reading for December 2015.

For ECB, current rates environment is historically unprecedented. Based on the data from January 1999, current episode of low interest rates is now into 100th month in duration (measured as the number of months the rates have deviated from their historical mean) and the scale of downward deviation from the historical ‘norms’ is now at 4.29 percentage points, up on 4.24 percentage points in December 2015.

Since January 2016, the euribor rate for 12 month lending contracts in the euro interbank markets has been running below the ECB rate, the longest period of negative spread between interbank rates and policy rates on record.

Currently, mean-reversion (to pre-2008 crisis mean rates) for the euro area implies an uplift in policy rates of some 3.1 percentage points, implying a euribor rate at around 3.6-3.7 percent. Which would imply euro area average corporate borrowing rates at around 4.8-5.1 percent compared to current average rates of around 1.4 percent.

3/1/17: Euro growth greets 2017 with a bit of a bang

December marked another month of rising economic activity indicator for the euro area. Eurocoin, a leading growth indicator published by Banca d’Italia and CEPR notched up to 0.59 from 0.45 in November, implying annualised growth rate of 2.38 percent - the strongest growth signal in 67 months. It is worth remembering that in 2Q and 3Q 2016, real GDP growth slumped from 0.5% q/q recorded in 4Q 2015 - 1Q 2016 to 0.3% in Q2-Q3 2016. Latest 4Q 2016 reading for Eurocoin implies growth rate of around 0.47 percent, slightly below 1Q 2016 levels, but above the 0.31% average for the current expansionary cycle (from 2Q 2013 on).

Charts below illustrate these dynamics

Cyclical trends in growth rates currently imply ECB policy rate mispricing of around 2.0-2.5 percentage points (see chart below).

Meanwhile, inflationary dynamics, based on 12mo MA, suggest current monetary policy environment providing only a weak support to the upside.

The growth dynamics over the last 12 months are not exactly convincing. Even at currently above 2Q and 3Q forecast for 4Q 2016, FY 2016 growth is coming in at 1.58% annualised, against FY2015-2016 growth of 1.65%. Overall, this environment is unlikely to drive significant changes in ECB policy forward, as Frankfurt will continue to attempt supporting growth even if inflation ticks up to 0.4-0.5% q/q range for 12 months moving average basis.

11/11/2016: Europe's 'Convincing' Recovery

Europe's strong, convincing, systemic recovery ... the meme of the European leaders from Ireland all the way across to the Baltics, and save for Greece, from the Mediterranean to Arctic Ocean comes to test with reality in the latest Pictet Quarterly and if the only chart were all you needed to see why the Continent is drowning in populist politics, here it is:

As Christophe Donay and Frederik Ducrozet explain (emphasis is mine):

"Since 2008, the world’s main central banks have used a vast array of transmission channels: currency weakening to reboot exports; reflation of asset prices to boost confidence; a clean-up of banks’ balance sheets to boost the credit cycle. But, ultimately, all these measures have failed as economic growth remains subdued. Indeed, the belief that countries have become trapped in suboptimal growth and that developed economies, especially in Europe, look set to complete a
‘lost decade’ of subpar growth (see graph) since the financial crisis forms the third strand of criticism of monetary policy."

Whatever one can say about the monetary policy, one thing is patently obvious: since the introduction of the Euro, the disaster that is European economy became ever more disastrous.

Enter Trumpist successors to characterless corporatist technocrats... probably, first for worse, and hopefully later, at least, for better...